In the second-part of our special focused on global corporates, industry experts trade views on whether there are any safe havens left in the asset class and how global growth will impact returns.
James Briggs, a credit portfolio manager at Henderson Global Investors, believes the themes that dominated 2015 will remain in 2016, particularly global central bank policy direction, commodity prices, emerging market conditions and rising idiosyncratic risk.
After a period of mixed messages from the Fed, he is hoping to see more consistent language on rate direction, otherwise interest rate volatility is likely to increase. The next few months, he believes, will be crucial.
‘We will continue to set great store in our bottom-up security selection and are likely to make greater use of shorts via credit default swaps,’ he said. ‘Since volatility is likely to be a feature of 2016, we’ll seek to exploit this by taking smaller, more nimble positions.’
Briggs suggests spread widening has created pockets of value, while the increase in idiosyncratic risk has a useful side effect in as much as it allows for greater alpha generation from good security selection.
‘This is something that is more challenging when credit markets move in unison,’ he said. ‘Prospects for identifying value are stronger lower down the credit spectrum, so we would expect to maintain our preference for BBB-rated bonds over AA or A-rated.’
Christophe Donay, chief strategist at Pictet Wealth Management, expects long-term interest rates in the US to rise gradually to around 2.7% by the end of 2016, pointing out that the Fed tightening is likely to be unusually drawn-out.
‘We think that there will only be three interest rate rises between now and the end of 2016,’ he says. ‘The 10-year treasuries are on track for a poor year in terms of returns in 2015 but are likely to remain attractive to protect portfolios against shocks to equity markets, given their negative correlation with equities.’
Bryn Jones, fixed income director for Rathbones, isn’t worried about the prospect of rising interest rates in the US and the UK – but is concerned about the outlook for China, which has barely been out of the headlines over the past year.
‘I think a further Chinese devaluation would have a big impact, as would a hard landing in China,’ he says. ‘It’d worry us because it could create deflationary pressures and further falls in commodity prices which could affect energy producers and bring down the cost of goods.’
As a corporate bond manager he is positioned for an inflationary environment with an economy and earnings that are going to grow, whereas deflation isn’t good for companies as it means they are unable to increase their earnings.
‘I can deal with interest rates rises but what I don’t like are defaults,’ he says. ‘There are two reasons why they could happen – major deflation pressure or rates going up too quickly, and what we can’t control is a nasty period of deflation.’
Bond yields remain low by historical standards, offering a poor balance of risk and reward, argues Lewis Aubrey-Johnson, head of fixed interest products at Invesco Perpetual. ‘In view of this we remain defensive in our positioning with significant allocations to liquidity through cash, short-dated and government agency bonds,’ he says.
This strategy should mean that the fund group is well placed to exploit more attractive opportunities when they arise. ‘With core government bonds offering a poor balance of risk and reward, we are maintaining low duration positions in the funds, which should mitigate the impact of rising bond yields,’ he says.
Many of his funds corporate bond holdings are within the financial sector, particularly the subordinated debt of high quality European banks.
‘The creditworthiness of the sector has improved significantly since the global financial crisis and we find these securities continue to provide a reasonable level of income for the risk,’ he says.
‘In recent months there has been a significant pick up in yields within sub -investment grade bonds. We are closely monitoring the situation, but think it is still too early to materially increase exposure.’
At the end of the day companies will always need to borrow money, so the question is how much people charge them to do this, according to Kelly Prior, an investment manager in the F&C Multi-Manager team.
‘We have just passed through an incredibly accommodative period where the lender was hungry for yield and happy to forgo elements of protection, such as legal rights within the structure of the debt, in return for yield,’ she says.
The question to be answered is how efficiently companies use this money to secure future growth, especially given evidence that equity buybacks have been the preferred use of capital. This is good for short term stock prices but not great investments for the future.
‘As the thirst for yield abates and the need for outstanding debt to be refinanced approaches, inflation could start to reappear thanks to base effects alone,’ she says. ‘From here I think it is safe to say things are going to get interesting.’
‘The rate driven element of return depends on the economic backdrop, direction of interest rates, inflation and government backdrop, while the credit element is made up of default and illiquidity risk,’ he says. ‘In investment grade corporate bonds the rate element will always be the dominant contributor.’
Benstead doesn’t subscribe to what has been the consensus bond market bubble view of recent years, believing that a combination of debt, demographics, deficits and deflationary pressures will continue to deliver sub-trend growth. ‘This will at worst limit any fall in gilt prices,’ he says. ‘In addition, estimates of the first hike in UK rates continue to get pushed further out into 2016.'
Looking ahead, while he recognises the more attractive investment grade valuations currently on offer, he remains cautious on credit quality going forward.
‘Companies continue to increase leverage to reward shareholders, extend their maturity profile and plug pension fund deficits, which are all credit-negative trends,’ he says. ‘On yields we are more sanguine, with any move higher likely to be met by credit buying from yield-starved pension funds and insurance companies.'
These comments originally appeared in the December-January edition of Citywire Global magazine.